REGIONAL PROTECTION IN
Evgenia Kolomak
Statement
of purpose
Regional leaders were inclined to interference in the
regulation of regional economy and to protection of local producers almost
everywhere in
The project has an aim to study how significant the
barriers erected by the regional administrations for interregional flow of
goods are. The project also considers the consequences of the regional
protectionism for economic development of the territories.
Review
of literature
I. Theoretical issues
Literature on the economics of transition regards the price
liberalization as a key element of transition, because it is a necessary
condition for the introduction of the market mechanism and for the improvement
in the allocation of resources. These studies deal with important efficiency
dimension to price liberalization (Lipton and Sachs (1990), Boyko
(1992), McKinnon (1991)). However, there is also an important redistributive
dimension to price liberalization, and this consideration is a political
economics’ argument (Drazen (2000), Persson and Tabellini (2002)).
What legislators should put in place depends on the political acceptability of
the reforms. Roland (2000) writes that the political constraints affect the
speed and design of reforms.
There are two aspects of the redistribution that price reforms cause:
between individuals and between regions. Individual heterogeneity with
differences in income is a fact of life. Sah (1987)
compares alternative allocation systems. It is shown that poor people prefer
rationing to nonintervention of government, but the rich are better off under
nonintervention than under other systems. The political acceptability of price
reform may depend on the income structure of constituency. The between regions
distributive dimension to price reform is a topic of political economy of
international trade policy (Krugman and Obstfeld (1994), Caves, Frankel and Ronald (1996)) where
one of the discussions is focused on national welfare arguments for and against
protectionism. Applying the results to transitional economy Kruegel
and Ciolko (1998) demonstrate that the hypothesis of
the endogeneity of price liberalization variable can
not be rejected. The worse the initial conditions for transformation, the
greater the probability of the deep transformation recession is, and hence
there are more likely delays in liberalization. When initial conditions are
favorable, rapid liberalization is feasible and preferable. Castanheira
and Popov (1999) also suggest that the speed and
extend of price liberalization may be endogenous,
liberalization policy may depend on the initial conditions and magnitude of the
decline in output as a result of liberalization.
The political constraints are reinforced when the fact that bureaucrats
and regulators may benefit from the persistence of price control is taken into
account. Shliefer and Vishny
(1992) applying a rent-seeking model, show that price control creates shortage
rents for state sector and represents opportunities for soliciting bribes.
Another explanation of low prices is given by Berkowitz (1996). The theory
developed in this paper assumes that local politicians are motivated to serve
constituents rather than to collect bribes. The model predicts that local
government would choose a market clearing price when, firstly, private sector
is monopolized, and, secondly, the share of nonresidential consumption within a
jurisdiction is high.
So the political constraints may make a gradual price reform preferable
despite its efficiency costs (Dewatripont and Roland
(1992 a, b) Roland (2000)). Milder reforms are the only way to speed up the
process and enhance political acceptability. Bertocchi
G. and M. Spagat (1997) give another explanation for
gradualism and reversion in the price reforms, applying learning model they
show that instability, which economies in transition are faced, dampens
learning effect and make policy more gradual.
The economic distortions resulting from partial price liberalization are
discussed in Murphy, Shleifer and Vishny
(1992). The partial price reforms encourage diversion of inputs away from the
regulated sector towards enterprises that are less constrained by arbitrarily
regulated prices. When only a few regions impose maximum prices, they hurt
themselves as well as the producers, and benefit enormously the regions that
have not restrained prices which simply free ride on them.
Summarizing literature on price liberalization Castanheira and Popov (1999) write that there is no theoretical evidence that a big bang approach is associated with less cost than the gradual one and there is no persuasive empirical evidence that fast liberalization performed better than slow one. Liberalization should and would lead to better performance in the longer run.
Features of local policy depend also on the attitudes towards the governments. Paper by Edwards and Keen (1996) synthesizes the two extremes: the view of government as a Leviathan and the view of government as a benevolent maximiser of their citizens’ welfare. The policy-makers have quasi-concave preferences defined over some item of public expenditures which, while financed from general revenues, benefits only the policy-maker, and the welfare of their representative citizen.
Polishchuk
(2000) shows that under certain assumptions a revenue-maximizing Leviathan-type
government might offer better conditions for economic growth than a benevolent,
which is concerned about economic well-being of its constituency at large.
II. Stylized
facts and estimations for Russia
1. Documents adopted at sub-federal level in
2. Tools of the regional regulation includes as direct (price ceiling,
making-up price, limitations on profitability, limitations on trade extra
charge, declaration about change in price) as indirect methods (tax exemptions,
credits, subsidies, budget compensations) and differ essentially among the
regions.
3. Growth of private wholesale trade and «porosity» of the interregional
borders have undermined attempts of some regional administrations to implement
an autarchy policy in food supplying. For instance, in 1995-1996 the famous “Ylyanovskaya” system of control over price and supply of
food failed and was discontinued (Хенсон (2001)). However the sub-federal documents erect barriers and
limitations on interregional flow of goods and services by introduction of
recurring certification, marking and “identification”, by direct prohibition of
export from and import in the region (Верховенство Конституции РФ и … ( 2000).
4. Price differentiation among the regions is very high in
5. There are not only high thresholds for interregional trade, which are
surprising for neighbouring regions, because
transport costs do not explain them. There are also observed diverged time
series of price levels in the regions. (Глущенко (2001))
6. A “culprit” of the weak market integrity of
7. Almost all regional policy-makers in
8. The main source of hidden subsidies to enterprises is as follows: power
subsidies in the form of overdue payments and of barter with artificially high
prices; non-payments in budget and non-budget funds, state purchase paid by
barter or by tax exemptions (Доклад Всемирного банка (2000), Коломак
(2001)).
9. An important feature of the debts and barter is that they provide the ground for the regional and local executive authorities to control the enterprises and level of their profitability. In exchange for the cooperation the policy-makers soften budget constrains of the enterprises and protect against external competition. More over barter became profitable business for mediators, including bureaucrats of the executive bodies. It resulted in a wide spread of scheme for extracting of benefits, of collusion and corruption. The extraction of political rent became a reason for the highest regional decision-makers to protect the enterprises (Доклад Всемирного банка (2000)).
10. However, the existence of tight local budgets does not explain why
many regions allocate scarce financial resources to subsidize basic consumption
goods (Berkowitz (1996)). Inter-budgetary relation is a factor provoking barter
and subsidies. The level of transfers from upper level budget to lower level
budget depends on actual expenditures of previous year. This makes regional
bureaucrats interested in exaggeration of expenses, in order to have a
possibility to obtain more transfers next year, or to provide a higher share of
taxes distributed between different budgetary levels. Barter
payments is an easy way of reaching this aim. At the federal level such
practice was stopped in 1999-year budget (Доклад Всемирного банка (2000)).
The empirical estimations have shown
positive and statistically significant correlation between subsidies granted to
industrial, agricultural and constructing enterprises and VAT transfers,
between tax exemptions to branches of industry and transfers and between subsidies and level of
price regulation.
11. A characteristic of the regional budgets is high level of overdue
for salary and transfers to population (more 40%), the
next item is overdue to infrastructure monopolies, supplying public utilities
(28%). Hence, the biggest part of burden, resulted from hidden subsidies to
enterprises is imposed on population, what contradicts to thesis that
subsidizing and help to enterprises are explained by social imperatives of the
regional authorities (Доклад Всемирного банка (2000)).
Methodology
I. A model
We assume that one of the most important aims of the price regulation is
protection of local producers. We consider a local market and the problem is
limited to partial equilibrium analysis. The local demand curve is Dlocal(p) and the inverse market demand curve is given by Pd,local(q). The supply curve of local producers
is Slocal(p) and is given by marginal costs Ps,local(q)
=MC(q). If there is no interregional and/or international trade the equilibrium
is determined by the condition Ps,local(q)
= Pd,local(q), P denotes the equilibrium
price.
Let the outside producer’s supply curve is Ps,outside(q)
and suppose that in the absence of trade the equilibrium price is higher than
in the situation of interregional trade. Assume also when there is no price
dispersion all consumers prefer domestic goods.
The equilibrium price in case of trade is determined by equation Ps,total (q)
= Pd(q), let it be P* and P*<P, where Ps,total
(q) = Ps,outside(q) + Ps,local(q). So the demand for local goods is Slocal (P*) and the demand for import
goods is equal to Soutside (P*)
- Slocal (P*).
Figure 1 illustrates the distribution of the market between local
producers and outside producers. Local producer’s share is Q1, the
outside producers sell at the market Q3-Q1.
The local government possesses instruments to protect local producers. Among these tools are price ceiling, subsidizing of local production, restrictions on export and import. The government’s problem is to design policy, which is efficient (maximizes its utility function) and acceptable.
The government’s utility function depends on attitudes towards
government. There are two extreme types of government presented in the
literature as stark alternatives: benevolent and Leviathan. When the government
is a benevolent, it is a maximizer of their citizens’ welfare - consumer’s
surplus (CS) and producer’s surplus (PS): CS+PS.
To show a different attention to the consumers and to the producers the utility
function is defined as W=CS+aPS, where 0<a<¥. A
Leviathan – government maximizes some item of public expenditures, while
financing from general revenues, benefits only the policy-makers (GR). A more general assumption is that
policy-makers are neither wholly benevolent nor wholly self-serving, an obvious
encompassing is that the policy-makers maximize a weighted average U=qW+(1-q)GR with qÎ[0,1].
The acceptability includes two
aspects: financial and political. The financial acceptability means satisfying
the budget constrain, local government expenditures should be less than
receipts. The receipts are in the form of taxation of the domestic aggregate
income (T), T=t*Y. Assume three expenditure items: price subsidies to local producers
(S), public goods (PG) and government’s revenues (GR). S=s*Y,
s is subsidies per unit.
Where b reflects the local government
ability to ‘soften’ local budget, it can be done through transferring expenses
of local policy to another budgets or by obtaining additional resources from
another budgets.
The political acceptability signifies that the government’s reform has
got a constituency support and therefore can be implemented. The
indicator function m(w) awards 1 when the condition of the acceptability
is fulfilled and 0 when it is not.
Function w measures the difference between the share of population supporting the reform and do not willing to vote for the reform. Assume that the population makes the decision based on not only economic criteria but on the political one too. The ‘economic’ component refers to utility function and includes consumer surplus of privately produced goods (CS), public goods (PG) and income structure (a share of rich people - R). The political component of the decision measures ‘antipathy’ to the government (A). Index 0 indicates the state before and index 1 indicates the state after the government’s interference.
Assume v¢cs>0, v¢pg>0, v¢r<0, v¢a<0.
The political
constrain modifies the government’s utility function:
U=m[qW+(1-q)GR].
Goals of the project are to obtain analytical results on cases of rationing, import and export quotation, subsidizing, tax exemptions for different attitudes towards government and in general cases.
II. Empirical estimations
A.
Hypotheses
Assuming the model is correct the empirical estimations will support the hypotheses as follows.
Hypothesis 1. Regional subsidizing, granting tax relief and
protecting price control are more active in the sectors where interregional
or/and international competition is higher. Transport costs could mitigate the
competition.
To test the hypothesis the price regulation and tax
relief by sectors will be estimated. These figures will be compared with the
estimations of the level of monopolization by the sectors in
Hypothesis 2. Regional protection with subsidies, tax exemptions
and price regulation is a feature of regions that have weak competitive
positions.
For testing these hypotheses connection between price
control, subsidies, regional tax relief and characteristics of initial
conditions and efficiency of regional economic development will be estimated.
Hypothesis 3.
Subsidies, tax relief and price regulation depends on macroeconomic demand and
supply shocks.
Data on regional subsidies and on the number of price
regulating documents adopted at the regional level in 1992 – 1998 confirms this
hypothesis (Appendix 3, table 4). There was growth of regional activity in
price regulation in 1995 and in 1998 and in subsidizing - in 1998. Those years
are famous for sharp devaluation of ruble, growth of consumer demand and prices
of goods of both import and domestic production.
For testing this hypothesis correlation with other
macroeconomic and local shocks will be estimated (energy and transport tariffs,
world market and internal political solutions).
Hypothesis 4. Regions demonstrating active subsidizing, tax
exemptions and price control have larger share of transfers from federal center
and higher level of non-payments in their budgets.
To test the hypothesis the dependence of level of
transfers received by region and of budget non-payments on price regulation
will be estimated. The preliminary estimations have shown positive significant
correlation between subsidies and transfers from the federal budget (Appendix
3, table 7).
Hypothesis 5. Regional protection through subsidies, tax exemption
and price control stimulates local production in the short-run,
however it is harmful for regional efficiency and rates of economic development
in the long - run.
Hypothesis 6. Regional restrictions on import increase local prices
and slow down trade activity and economic development in the regions in future.
To test two latter hypotheses indexes of regional economic
development in different years will be regressed on activity of the regional
price control.
Hypothesis 7. Assuming the regional authorities are unfriendly to
the market (with very few exceptions) the regional regulation is more active
where the government has got a wider constituency support.
To test the hypothesis activity of the regional
regulation will be compared with the share of votes in favor of the governor
came to power in the last election.
Hypothesis 8. The concentrated producer’s interests means higher
lobbying power to influence the government and to persuade it of the
protection.
To test this hypothesis the correlation of the
regional regulation and level of the regional specialization will be estimated.
The hypotheses of the empirical analysis will be
developed in the course of the development of the theoretical model.
B.
Methods of estimation
The observations have the panel structure and include characteristics of
the regions (about 89) over time period (1992 – 2000), let i=1,…N is index for region, and t=1,…T is index for time. The system of
the hypotheses shapes a system of the regression equations.
The suggested
estimators for such kinds of systems are EC2SLS (error component two - stage
least squares) and GMM (generalized method of moments) methods (Baltagi, 2001; Hsiao, 1986).
C.
Information
Testing of the formulated hypotheses assumes data on
price regulation at the regional level in
The documents adopted at regional level since 1992 are
collected in the legislative database "Consultant. Plus: Regional
Legislation". Materials on detailed structure of regional budget incomes
and expenditures (including subsidies) for 1996 - 2000 are available in
Ministry of Finance of the
Plan of the work
Development of the theoretical model, obtaining the
analytical results
Development of the hypotheses of the empirical
analysis
Collection and updating of information for the
empirical analysis
Regression estimations and analysis of the results
Report, discussion
Policy implication
The results of the project might be applied in
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